Few issues escalate a construction dispute faster than a bank guarantee. For developers, it can provide immediate access to funds when a project goes wrong. For builders, it can mean losing hundreds of thousands of dollars overnight, often before a court or tribunal has determined who is right.
That is why bank guarantees are one of the most important, and often misunderstood, provisions in construction contracts.
Why Bank Guarantees Matter
A bank guarantee is intended to protect a developer if a builder fails to meet its contractual obligations. It allows the developer to access funds without first having to commence lengthy court proceedings or wait for a dispute to be resolved.
For builders, the benefit is equally important. Rather than tying up cash as security, a bank guarantee preserves working capital so funds remain available to deliver projects and grow the business.
While projects are progressing smoothly, bank guarantees rarely receive much attention.
It is when a dispute arises that they often become one of the most valuable assets on the project.
A Powerful Tool for Developers
A bank guarantee provides developers with valuable commercial protection.
If a builder becomes insolvent, fails to rectify defects or abandons the works, access to security may provide the funds needed to complete the project or rectify defective work without waiting years for litigation to conclude.
However, calling on a bank guarantee is not without risk.
Every construction contract sets out when a developer is entitled to have recourse to security. If those contractual requirements are not followed, the developer may face urgent court proceedings, damages and unnecessary legal costs.
Before making a demand, developers should ensure they have a clear contractual entitlement to do so.
A Significant Risk for Builders
Many builders believe that if they dispute a developer’s claim, the bank will refuse to pay under the guarantee.
In most cases, that is not how bank guarantees operate.
Most bank guarantees are payable on demand. Provided the developer’s demand complies with the terms of the guarantee, the bank will generally make payment without considering the underlying dispute.
For builders, the consequences can be significant.
A call on security can reduce cash flow, affect banking facilities, limit bonding capacity and place pressure on other projects. Even if the builder ultimately succeeds in the dispute, recovering those funds may take considerable time and expense.
Can a Builder Stop a Bank Guarantee Being Called?
In some circumstances, yes.
Australian courts may restrain a call where:
- the construction contract does not permit recourse to security in the circumstances;
- the developer has failed to comply with mandatory contractual requirements;
- the demand is fraudulent; or
- the proposed call is unconscionable.
Because these applications are urgent, builders should seek legal advice as soon as they become aware that a call on security is being considered.
The Clause That Deserves More Attention
One of the most overlooked provisions in a construction contract is the recourse to security clause.
Developers sometimes assume they can call on security whenever they believe money is owed.
Builders sometimes assume the security cannot be called until liability has been determined.
Neither assumption is necessarily correct.
The answer almost always depends on the wording of the construction contract.
The Bottom Line
For developers, a bank guarantee is a valuable risk management tool that can protect a project when things go wrong, provided it is exercised in accordance with the contract.
For builders, a bank guarantee represents a significant commercial exposure that extends well beyond the value of the security itself. A call on security can affect cash flow, financing arrangements, future tender opportunities and the overall financial position of the business.
Whether you are negotiating a construction contract or managing a live dispute, the bank guarantee provisions deserve careful attention. Understanding when security can be called, and when it cannot, can make the difference between protecting your commercial position and becoming involved in costly and time critical litigation.